BofA, JPMorgan Say Time to Sell as Europe Stocks Face Risks

(Bloomberg) — The rebound in European equities since mid-March has failed to win over strategists, who predict that the sustained campaign of central-bank interest rate hikes will stall the rally.

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They are sticking to their gloomy outlook for the rest of 2023, unconvinced by a 10% advance in the Stoxx Europe 600 so far. The benchmark index is set to fall to 450 points by year-end, according to the average of 15 forecasts in a Bloomberg strategist survey, implying a drop of 4% from Friday’s close.

“Monetary policy has been tightened by the sharpest pace in 40 years, which is resulting in a sharp deterioration of credit and monetary conditions,” Bank of America Corp. strategist Milla Savova said in emailed comments. “We expect this to lead to recessionary growth conditions over the coming months, which, in turn, would be consistent with a meaningful widening in risk premia.”

The BofA strategists expect earnings forecast downgrades to add to the headwinds, cutting their year-end target for the Stoxx 600 to 410 from 430 last month, implying about 13% downside from here. For Savova and her team, the low point for stocks should come early in the fourth quarter, when the economic cycle is expected to bottom, dragging the benchmark to as low as 365.

“We think this will mark the next big buying opportunity for equity investors, as growth momentum starts rebounding in response to a fading drag from aggressive monetary tightening,” Savova said.

European equities have recouped all the losses induced by the banking turmoil in the US and the collapse of Credit Suisse Group AG. The Stoxx 600 surged to the highest since February 2022 this month, buoyed by an economic recovery in China, and rapid intervention by authorities to contain the banking crisis. The trouble is that manufacturing data for the continent have continued to deteriorate, while inflation remains too high for central banks to stop hiking rates.

The range of predictions for the benchmark index has narrowed, taking on a negative skew. The most optimistic forecast is 480 from Deutsche Bank AG and ING Groep NV, an upside of just 2.3% from Friday’s close. TFS Derivatives still holds the most pessimistic view at 380 points, representing a drop of 19%.

The largely downbeat assessment from sell-side strategists is mirrored by the actions of the investment industry. According to the Bank of America European fund manager survey in April, 70% of investors expect weakness in the region’s equity market over coming months in response to monetary tightening, up from 66% last month. Meanwhile, 55% see stocks heading lower in the next 12 months, up from 42%. Sticky inflation leading to more central bank tightening is seen as the most likely cause of a correction, followed by weakening macro data, the survey showed.

Citigroup Inc. strategists led by Beata Manthey said in a note on Tuesday that they favor US stocks over Europe as American shares tend to perform more defensively during EPS slowdowns. Even if European economic growth beats that of the US, European equities and earnings will come under pressure, Citi said.

While most strategists in the Bloomberg survey have stuck to their forecasts or slightly adjusted their view downward in the past month, some found justification for an increase. State Street Global Advisors, for instance, raised its target to 475 from 455, although this only implies limited upside for the rest of the year.

“The financial contagion from the banking sector in March had been very well contained so far and markets have rebounded,” Frederic Dodard, head of EMEA portfolio management at State Street Global Advisors, said in emailed comments. The firm continues to favor European equities over other regions, but sees a modest risk from negative guidance and additional downgrades to companies’ 2023 and 2024 earnings forecasts, he added.

The first-quarter earnings season has kicked off with some positive surprises, and there could be more to come. But this shouldn’t be extrapolated as a signal of stronger stock performance, according to JPMorgan Chase & Co. strategists. Low profit expectations have been easy for companies to beat, while the numbers also got a leg up from economic activity that was better than in the first-quarter of 2022, they argue.

“The question is whether the stocks will rally much further on the back of beats, post an already strong rally,” wrote strategists led by Mislav Matejka in a note on Monday. “We advise to use any strength on the back of positive first-quarter results as a good level to reduce from.”

–With assistance from Jan-Patrick Barnert and Tommaso Isak Rognoni.

(Updates with Citi comments in ninth paragraph)